Could 30 Year Mortgages Cause a New Bubble?

In case you missed it: in a recent piece, mortgage finance and housing expert Edward Pinto writes that the 30-years mortgage could well be the cause of a new housing bubble.

Federally insured banks, thrifts and credit unions hold $1.7 trillion in Fannie Mae-, Freddie Mac- and Ginnie Mae-guaranteed securities, while an additional $2.2 trillion are held by local, state and federal governments and agencies. Both categories have increased by about 30 percent since 2007. As a result the government, banks and other financial institutions backed by the Federal Deposit Insurance Corp. now hold 52 percent of outstanding agency securities. Most are backed by 30-year fixed-rate mortgages.

Federal policy has, in effect, created a closed system whereby the government subsidizes the rate on 30-year mortgages, guarantees the credit risk and then puts itself on the hook for most of the interest-rate risk

Because these securities are backed by the government, they are considered highly liquid. But being highly liquid doesn’t protect against wide price swings, and securities tied to 30-year mortgages are notorious for price volatility. If mortgage-loan rates went up only by a moderate amount, say from 4 percent to 5.5 percent, the value of the securities held by banks and other financial institutions would go down by about 6 percent, or $100 billion based on the size of their holdings. A larger increase in mortgage rates — to say 9 percent — may put us on the verge of another financial meltdown.

Edward Pinto was a an executive vice president and chief credit officer for Fannie Mae. He has done groundbreaking research on the role of government housing policies in the lead-up to the financial crisis. Pinto is available for interviews and can be reached at [email protected]

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